In a case of importance to foreign representatives of foreign debtors seeking the assistance of US courts pursuant to chapter 15 of the Bankruptcy Code, the US Court of Appeals for the Second Circuit has held that the debtor eligibility requirements of section 109(a) of the US Bankruptcy Code apply in cases under chapter 15 as they would in cases under other chapters of the Bankruptcy Code. The decision in Drawbridge Special Opportunities Fund LP v. Barnet (In re Barnet), Case No. 13-612 (2d Cir. Dec. 11, 2013) (“Barnet”), means that in addition to the various requirements for relief contained in chapter 15 itself, a foreign debtor must satisfy the threshold eligibility requirements under section 109(a) of the Bankruptcy Code to be a debtor: namely, the foreign debtor must reside or have a domicile, a place of business or property in the United States.

The decision is a departure from the law and practice of cross-border insolvency proceedings under the former section 304 of the Bankruptcy Code, the predecessor to chapter 15, under which several courts had concluded that having property in the United States was not a condition precedent to relief in an ancillary US proceeding. Given that courts have liberally construed what constitutes “property in the United States” for purposes of a debtor’s eligibility under section 109(a), the requirement that a foreign debtor must be an eligible debtor under section 109(a) in order to qualify for any relief under chapter 15 should not pose a substantial barrier to the commencement of cases under chapter 15 in the vast majority of situations.

Chapter 15

Chapter 15 largely incorporates the Model Law on Cross-Border Insolvency promulgated by the United Nations Commission on International Trade Law. It was enacted to facilitate cooperation and coordination with foreign proceedings, to facilitate fair and efficient administration of cross-border insolvencies, and to protect and maximize a foreign debtor’s USbased assets. Chapter 15 applies when a foreign court or foreign representative seeks assistance in the United States in furtherance of a foreign proceeding.

Under chapter 15, a foreign representative of the foreign debtor files a petition for recognition by the US bankruptcy court of a foreign insolvency proceeding as either a “foreign main proceeding” or a “foreign nonmain proceeding.” Recognition of a foreign insolvency proceeding as a “foreign main proceeding” affords a foreign representative substantial automatic relief, including application of the “automatic stay” of section 362 of the Bankruptcy Code to the debtor and property of the debtor within the territorial jurisdiction of the United States and the ability to operate the debtor’s business within the United States under section 363.

In addition to the automatic relief that comes with the entry of an order granting recognition of a foreign proceeding as a foreign main proceeding, section 1521 of the Bankruptcy Code authorizes the bankruptcy court to grant discretionary relief as appropriate under the facts and circumstances. This discretionary relief may include providing for the examination of witnesses, the taking of evidence, or the delivery of information concerning the debtor’s assets, affairs, rights, obligations, or liabilities.

The framework reflects the full commitment of the United States to cooperate and coordinate with foreign insolvency proceedings to, among other things, protect the value of the debtor’s assets.

Barnet

In Barnet, the debtor was the subject of a liquidation proceeding in Australia. The debtor did not transact business, or have any operations, in the United States. The debtor’s foreign representatives were unaware of any creditors of the debtor in the United States, at least as of the filing of the petition. But the foreign representatives were in the process of investigating and prosecuting potentially valuable causes of action on behalf of the debtor’s estate. The foreign representatives believed that the debtors “may have assets in the United States in the form of claims or causes of action against entities located in the United States.” The foreign representatives intended to utilize chapter 15 to facilitate their investigation.

Drawbridge Special Opportunities Fund LP (“Drawbridge”) objected to recognition of the foreign proceeding, arguing that the foreign debtor was not eligible for relief under chapter 15 because it failed to meet the criteria to be an eligible debtor pursuant to section 109(a) of the Bankruptcy Code. Section 109(a) of the Bankruptcy Code provides, in relevant part, that “only a person that resides or has a domicile, a place of business, or property in the United States … may be a debtor under [the US Bankruptcy Code].” The foreign representatives had identified no residence, domicile, or place of business in the United States. As for property in the United States, Drawbridge argued that the foreign representatives only identified potential claims against unknown parties. Even if the foreign representatives could identify actual claims, Drawbridge argued, such claims are considered to be assets located in the domicile of the plaintiff, not the defendant. Drawbridge argued that the foreign representatives had not met their burden under section 109(a), and, accordingly, the petition should have been dismissed.

The bankruptcy court ultimately entered a recognition order under chapter 15 and a separate order granting the foreign representatives leave to conduct discovery against Drawbridge, among others. The bankruptcy court held that a debtor, within the meaning of chapter 15, is not required to have a domicile, residence, place of business, or property in the United States. In the absence of precedent from the Second Circuit, the bankruptcy court was persuaded by holdings of courts in other chapter 15 cases suggesting that the presence of assets in the United States was not a necessary prerequisite to a foreign representative’s seeking injunctive relief or discovery. The bankruptcy court reasoned that this approach was consistent with the law and practice of the former section 304 of the Bankruptcy Code, the predecessor to chapter 15, where several courts had concluded that the presence of US assets was not a requirement for relief under an ancillary section 304 proceeding.

Drawbridge appealed from the recognition order, and the bankruptcy court certified the issue for direct appeal to the Second Circuit. On certification, the bankruptcy court reasoned that requiring a foreign representative to identify US assets prior to recognition would permit concealment of assets in the US and thus defeat the fundamental purposes of chapter 15. The bankruptcy court also reasoned that the issue was a matter of public importance, the resolution of which “will dramatically impact the jurisdiction of the United States bankruptcy courts and the use of Chapter 15 to assist in the administration of cross-border insolvency cases and the legitimate investigation of claim and assets in the United States.” After analyzing certain complicated issues of appellate standing, the Second Circuit vacated the bankruptcy court’s recognition order and remanded to the bankruptcy court for further consideration.

At issue on appeal was whether the eligibility requirements of section 109(a) apply to a debtor under chapter 15 of the Bankruptcy Code. The Second Circuit engaged in a plain meaning analysis of the relevant statutory provisions and answered this question in the affirmative. The Second Circuit observed that section 103 of the Bankruptcy Code (Applicability of chapters) provides that chapter 1 of the Bankruptcy Code applies in a case under chapter 15. “Section 109, of course, is within Chapter 1 of Title 11 and so, by the plain terms of the statute, it applies ‘in a case under chapter 15.’”

The foreign representatives argued that the purpose of chapter 15 would be undermined by application of section 109(a) and made some textual arguments based on examining certain provisions of chapter 15 itself, but the Second Circuit reasoned that the plain meaning of sections 103 and 109(a) of the Bankruptcy Code controlled. In support of a petition for recognition under chapter 15, therefore, a foreign representative must demonstrate that the foreign debtor resides or has a domicile, a place of business, or property in the United States.

Observations

The Second Circuit’s ruling, although significant, will likely have little practical impact for the vast majority of foreign debtors. Courts have applied the eligibility requirements of section 109(a) liberally, particularly in examining whether a debtor has “property in the United States.” Courts have found that entities whose business operations and assets were overwhelmingly located abroad may be debtors in plenary chapter 11 cases upon a showing of a mere “peppercorn” of property interests located in the United States. In the case of In re Marco Polo Seatrade B.V., 1 for example, the debtors were found to be eligible for chapter 11 relief with minimal property located in the United States. The Marco Polo debtors had hundreds of millions of dollars of assets and liabilities, but, as for US property, they only possessed an economic interest in a New York pool account and the unearned portion of a retainer held by their US bankruptcy counsel in a separate New York account.

The limits of those strategic filings remain to be seen as foreign creditors often argue that such cases are filed in bad faith and disruptive of their reasonable expectations. But ancillary proceedings under chapter 15 are different, of course, from plenary cases under chapter 11 or chapter 7, insofar as a chapter 15 proceeding is designed to be one focused on the US and in aid of a proceeding pending in another jurisdiction. On remand in Barnet, it will be interesting to see whether the foreign representatives rely on the debtor’s retainer with US bankruptcy counsel as a basis for eligibility under section 109(a), not unlike the chapter 11 debtors did in Marco Polo, and, if so, whether any objections of Drawbridge and other interested parties thereto will be successful.